One of the special features of the negative list based service tax regime, introduced with effect from 1st July, 2012, is the introduction of the concept of declared services (Section 66E of the Finance Act, 1994). Declared services, which are actually described in 9 serial entries, are required to be treated as ‘service’ for the purposes of the Finance Act vide Section 65B(44) being the definition for service. Many of these nine entries have had the distinction of triggering intense debate in the past about the vires of the levy of service tax itself. But the most intriguing and tricky entry out of them is:
“66E (e) – agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act.”
This entry is the subject matter of this article.
It will be convenient if the above entry is split into its components:
- Agreeing to the obligation to refrain from an act.
- Agreeing to the obligation to tolerate an act.
- Agreeing to the obligation to tolerate a situation.
- Agreeing to the obligation to do an act.
The above clauses, all four of them, indicate a basic structure – a request to refrain/tolerate/do and a corresponding agreement to oblige. Very clearly the person making the request is the service receiver and the person agreeing to oblige is the service provider.
In a typical situation the person who needs a service will approach a person who can provide the service. For example, a company X might approach a trader not to deal in the goods of a competitor company Y against whom it is in stiff competition in the market. And if the trader obliges to do so for a certain consideration, it will amount to agreeing to the obligation to refrain from an act. Will the above transaction be viewed differently if the trader approached company X and offered not to deal in the goods of company Y provided a certain amount is paid in return, and company X accepts the offer? It certainly will not, as the desire to stop the trader from dealing in the goods of company Y, did exist in company X, and the fact as to who approached who, is immaterial in this regard. Normally the person who needs a service approaches the person who can provide the service, but when a person who can provide a service approaches a person who might need a service, and when the person approached says yes he needs the service, then it would still result in the same transaction namely the service provider has provided service to the service receiver who needed the service.
The purpose of drawing attention to the above situation is to visit certain typical transactions that we encounter in the name of terms and conditions, damages, penalties, compensation etc. in agreements and contracts entered into between parties. Notice period and notice pay, forming part of terms and conditions settled between employer and employee, is a good example to consider. What is the implication of section 66E (e) of the Finance Act on such clauses?
Before we start finding the answer to the above question certain fundamental concepts are required to be understood:
(1) A service can be simple in the sense that the activities undertaken are minimal to meet a simple need/desire. Fixing a punctured tyre will be an example in this category.
(2) A service can be complex in that several elements are bundled together and offered to the client. Annual maintenance of a fleet of trucks for a transport company, which will include undertaking specific repairs of different kinds contingent upon need arising; undertaking preventive maintenance checks periodically of different parts and components; and general cleaning of the trucks for better upkeep, is an example in this category.
In the first example above there is clarity as it is simple and there should be no confusion about taxability. In the second example several questions can arise for which answers have to be found. Is there a single supply or are there multiple supplies? What happens when there is a single rate per truck per year for all the three elements – repairs, maintenance and cleaning? Will it then be a single supply? What happens when separate rates are settled for each element and the client is charged only for what he asked for as per these rates? Will it then amount to multiple supplies of services? What happens when time lines are fixed for the completion of different jobs/activities failing which a provision for payment of penalties is agreed to based on a clear formula? Will there then be a case for invoking Section 66E (e) for a separate service provided by the transport company?
In finding the answers to the questions raised above an important factor to look into is the intent and understanding between the transacting parties. This can most often be deciphered from the clauses in the agreement. When a single rate is fixed per truck per year for all the three elements without any flexibility for making any variation, then it would be correct to say that the parties visualized a single supply consisting of a bouquet of services. The provisions of Section 66F may have to be applied to settle assessment of service tax in such a situation. It will then not be necessary at all for looking at splitting the single rate for differential treatment of each of the elements.
When different rates are settled for each element and for different types of jobs within each element, and the transport company is charged as per these rates as and when jobs are undertaken on request, then the arrangement is one of, as many supplies as there are jobs. Every job undertaken has to be seen as a supply and assessed to service tax. So far so good. Now comes the problem area.
When time lines are settled for each job with further provisions for dealing with delays, there can arise two types of situations: one, where different rates are fixed for the same job completed – Rs. 100 if completed in optimum time (2 days), Rs. 90 if completed between 3 and 4 days, and Rs. 80 if completed in more than 4 days. Here the parties are settling prices. There is no scope therefore to say that there is an element of fine/penalty built into the prices. Two, where only one rate is fixed for the job, with a provision to collect a sum in the form of penalty – Rs. 100 for completing the job and a penalty of Rs. 5 per each additional day delayed beyond 2 days, payable to the transport company. Here the parties are no doubt settling only one price, but the penalty for delaying the job, clearly indicates the intent to introduce a concept of deterrence to instill promptness, which is understood as such and accepted by the transacting parties. Will this constitute a different and distinct supply, namely an obligation on the part of the transport company to tolerate an act (failure to maintain promised deadlines) on the part of the person who undertook the job, in return for payment of the penalty amount? In my view the answer is in the affirmative.
Now coming to the question of the implication of Section 66E (e) on notice pay. The condition to pay an amount as notice pay in lieu of notice period, for the employer to agree to let go an employee, normally forms part of the terms and conditions of employment. This would mean that the employee while accepting the offer of employment, has not only understood the intent on the part of the employer in prescribing this exit condition, but has also accepted it. In other words the employee has understood and accepted the condition that in the contingency of his inability to provide the prescribed notice period, he can exercise the option of paying the notice pay as the consideration for the employer to agree to the obligation of letting him go, which the employer is bound to do as it is part of the terms and conditions already agreed to and settled between them. In my view therefore this transaction of the employer agreeing to the obligation of tolerating an act (quitting without any advance notice) on the part of the employee, for payment of a sum (notice pay), will be covered as a declared service under Section 66E (e).
The above issue is bound to be seen differently in different quarters. Grounds to say that such a transaction did not constitute a separate supply; or that it is a transaction not in the nature of a service, can and will always be found, and attempts to levy service tax will be challenged. Particularly a case can no doubt be made to argue that fines, damages, penalties etc. do not characterize a transaction of an activity for a consideration with express or implied contractual reciprocity. And furthermore as per Rule 6(2)(vi) of the Service Tax (Determination of Value) Rules, 2006 value of a taxable service does not include accidental damages due to unforeseen actions not relatable to the provision of service. We will need to wait and watch how this issue will finally be settled in the future.
[ The author is Director, Tax Practice, Lakshmikumaran & Sridharan, New Delhi ]